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The U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) are critical regulating entities for the financial services industry in the United States. They oversee financial markets to ensure that they are fair and orderly and to protect investors. The role of financial regulators is to facilitate a sound financial services industry that consists of markets, exchanges, and firms that comply with their laws and regulations.
As regulators, the SEC and FINRA exist to keep market participants safe from financial fraud and to help participants manage their investment risk. There are many reasons why investors should understand the roles and responsibilities of both the SEC and FINRA as well as how these regulatory bodies differ.
Key Points
• The SEC and FINRA both regulate U.S. financial markets to keep them fair, orderly, and focused on protecting investors.
• FINRA is a government-authorized self-regulatory organization that supervises broker-dealers and enforces rules for market transparency.
• The SEC is a federal agency that enforces securities laws and oversees FINRA, sitting above it in the regulatory hierarchy.
• FINRA’s role is narrower than the SEC’s, focusing on broker-dealer regulation, licensing, and margin account rules.
• Both agencies share the common goal of protecting investors from fraud, maintaining trust in U.S. financial markets, and offering free educational tools for investors.
What Is the Financial Industry Regulatory Authority (FINRA)?
FINRA is a government-authorized, not-for-profit organization that oversees U.S. broker-dealers. The organization’s purpose is to protect investors and uphold the integrity of financial markets to ensure they operate fairly. FINRA oversees hundreds of thousands of brokers throughout the U.S. and monitors billions of daily market events.
The SEC supervises FINRA in writing and enforcing investing rules that all registered broker-dealers in the U.S. must follow. FINRA makes sure that these firms comply with these rules, as it facilitates market transparency and educates investors.
FINRA Regulates Margin Accounts
FINRA also regulates margin accounts, which involve a customer borrowing funds from a firm to make trades. Under FINRA margin requirements, some securities cannot be purchased on margin, in which case a cash account must be used to deposit 100% of the purchase price.
FINRA rule 4210 requires traders to have a minimum of $2,000 in equity in their account to participate in margin trading. Traders must also maintain a minimum equity of 25% the total value of the securities held by the account. If this requirement is not met, the firm may need to liquidate the securities to bring the account to the required level.
💡 Quick Tip: One of the advantages of using a margin account, if you qualify, is that a margin loan gives you the ability to buy more securities. Be sure to understand the terms of the margin account, though, as buying on margin includes the risk of bigger losses.
Recommended: What Is Maintenance Margin?
What Is the Securities and Exchange Commission (SEC)?
The SEC is a market regulator whose purpose is to protect investors, maintain fair markets, and facilitate ways for businesses to access capital. This regulatory body consists of six divisions and 10 regional offices. It requires public companies, asset managers, and investment professionals to disclose important financial information so investors are equipped to make the best investment decisions.
The SEC will also enforce federal securities laws to keep lawbreakers accountable in the name of protecting investors. In order to maintain fair and efficient markets, the SEC monitors the market and adjusts rules and regulations according to the evolving market environment.
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FINRA vs the SEC
Both institutions were created to protect investors against investment fraud and maintain the integrity of U.S. financial markets, but there are differences between these regulatory agencies.
How Are FINRA and the SEC Different?
The SEC was created under the Securities Exchange Act of 1934, and one of its responsibilities is to oversee FINRA, which was created in 2007. FINRA is a self-regulatory organization that oversees and regulates its members’ actions. Unlike the SEC, FINRA is not mandated by the U.S. government. Rather, it’s a private, or self-regulatory organization (SRO) consisting of the registered broker-dealers that FINRA oversees.
The SEC, on the other hand, focuses more on protecting the individual investor. The SEC was born during the Great Depression with the goal of restoring investors’ confidence in financial markets, as well as enforcing the rules. FINRA’s role is narrower. It revolves around regulating brokerage firms and handles testing and licensing requirements, such as the Series 7 exam. All broker-dealers must be licensed and registered by FINRA.
How They Are Similar
Both FINRA and the SEC are responsible for protecting investors. Both organizations play important roles in upholding the integrity of the U.S. financial system and take action to protect the public from fraud and other financial bad practices. Both agencies offer tools and insights that help educate investors about how to secure their financial future.
The SEC is the ultimate regulatory watchdog of financial markets, and FINRA regulates the securities industry by overseeing stockbrokers. The work that comes out of the SEC and FINRA helps these agencies function smoothly. The SEC reviews FINRA’s regulatory work — such as managing required industry examinations and inspecting securities firms — which is vital to protecting investors and monitoring financial markets.
FINRA vs the SEC: A Quick Comparison
| FINRA | The SEC | |
|---|---|---|
| What is it? | A government-authorized not-for-profit that oversees U.S. broker-dealers (BDs). | A U.S. government agency and the ultimate regulatory watchdog of financial markets. |
| What is its purpose? | Upholds the integrity of financial markets, enforces rules for broker-dealers, and monitors the markets. | Focuses more on protecting individual investors. Created to restore investors’ confidence in financial markets and help firms access capital. |
| When was it created? | Created in 2007. | Created with the Securities Exchange Act of 1934. |
| Relationship with the U.S. government | A private SRO not mandated by the U.S. government, consists of registered BDs. | A U.S. government agency born of the Great Depression. |
| Function? | Enforces rules but has a narrower role than the SEC. Regulates BDs, manages testing and licensing requirements (e.g., Series 7 exam). All BDs must be licensed by FINRA. | Enforces rules, oversees FINRA, creates and enforces securities laws. |
| Public resources? | Yes, offers tools and insights that help educate investors about how to secure their financial future | Yes, offers tools and insights that help educate investors about how to secure their financial future |
How to Avoid Trouble With FINRA and the SEC
The best way to avoid trouble with FINRA and the SEC is to abide by their rules and regulations. And, if you give your money to an investment or financial professional to manage, you also may want to confirm that this professional is registered with the SEC and licensed to do business in your particular state. It also could be worthwhile to research whether they have ever been disciplined by regulatory agencies or if there are any prior complaints against these professionals.
Cash Accounts vs Margin Accounts
Two popular accounts that are typically opened by market participants are either cash accounts or margin accounts. Each type of account comes with its own regulations. With margin accounts — which are regulated by FINRA along with other financial institutions — you have the ability to borrow funds, but with a cash account, you cannot borrow funds.
For investors using cash accounts to purchase securities, there are regulations to abide by. To avoid violations, remember that you can’t borrow funds from your brokerage firm to pay for transactions in your cash account. Transactions using borrowed funds can only be made in a margin account.
The Takeaway
The SEC and FINRA exist to manage U.S. financial markets with investor protection top of mind. Their rules and regulations can be adjusted according to how the market is evolving. Understanding their mandates and goals is a great tool for investors to understand their rights as market participants in the event they fall victim to fraud.
If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.
FAQ
Does FINRA approve SEC rules?
No, the Financial Industry Regulatory Authority (FINRA) does not have oversight over the Securities and Exchange Commission (SEC). The SEC is higher in the regulatory hierarchy than FINRA, not the other way around.
Is FINRA part of the US federal government?
No, FINRA is not part of the U.S. government. It is an independent, private entity, while the SEC is a government-mandated organization.
Does FINRA report to the SEC?
Yes, FINRA is a self-regulatory organization that operates under the purview of the SEC. Any rule changes proposed by FINRA are reviewed by the SEC to determine whether they are consistent with the Securities Exchange Act of 1934.
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Options involve substantial risk of loss and the possibility an investor may lose the entire amount invested. Before starting options trading, investors should be familiar with the Characteristics and Risks of Standardized Options . TTax implications with options should be considered. Consult your tax advisor to understand any impacts to your taxes.
Trading securities on margin loans involves high risk and costs and is not suitable for all investors. It is possible to lose more than your initial investment when using margin. Please see more details at https://www.sofi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf
This article is not intended to be legal advice. Please consult an attorney for advice.
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